20 years of accurate predictions on China and the world economy
实事求是 - seek truth from facts, Chinese saying originally from the Han dynasty

02 September 2014

China's economic growth in the light of the findings of modern Western economic research

Since 1978 China has seen the most rapid economic growth of any major country in world history, and the most rapid increase of living standards of any major economy. Furthermore, following the beginning of the international financial crisis, China far outperformed any other major economy – in the seven years from 2nd quarter 2007 to 2nd quarter 2014 China’s economy grew by 78% and the US by 8%. In a single generation China has gone from a ‘low income’ economy to the verge of achieving ‘high income’ status by World Bank criteria.

This unprecedented economic development is sometimes explained in terms of unique ‘Chinese characteristics’, but Western economic research over the last 30 years confirms that the reasons for China’s economic growth are rooted in universal economic processes. To be more precise, while the combination of global forces producing economic growth is unique in China, and produces unique ‘Chinese characteristics’, the forces propelling China’s growth operate throughout the world economy.

These modern advances in Western measurement and analysis of the causes of economic growth have major implications for China. Some economists in China have claimed that its very rapid growth is ‘aberrant’ and not in conformity with economic theory. Instead, supposedly China must switch from a growth pattern based on high investment and exports to one based on productivity, more precisely Total Factor Productivity (TFP), growth. Unfortunately such arguments are based on economic methods and concepts that are 30 years out of date and which have been formally replaced by the UN, US and OECD.

Modern economic methods show that growth in the world economy, therefore including China, is fundamentally driven by high levels of investment and by globalisation, which is division of labour on an international scale. The aim of this article, therefore, is to outline the results of the most advanced Western economic methods and their implications for China. First a brief characterisation of the scale of China’s economic achievement will be given, as this establishes the fundamental implications of this for economic theory, and then the implications of modern Western economic research for understanding China’s growth will be analysed. In particular, attention will be given to the formally registered advances of measurement and understanding of economic growth in general, by international economic agencies, and to the most comprehensive application of these to the study of China and Asia’s economic growth – Vu Minh Khuong’s masterpiece The Dynamics of Economic Growth: Policy Insights from Comparative Analyses in Asia.

The historical scale of China’s economic success

The scale of China’s economic growth since 1978 is unprecedented in world history. To summarise a few key parameters:

Table 1 shows the percentage of global population in the world’s largest economies at the time they commenced rapid and sustained growth.1 No other economy remotely approaches the 22% of the world’s population in China in 1978 at the commencement of its sustained rapid economic development. China’s was seven times the relative percentage of the world population of the US or Japan and almost three times that of the USSR at the time of economic ‘lift-off.’

China’s growth in absolute terms in a single year far exceeds any other country in history. Measured at internationally comparable prices, i.e. parity purchasing powers (PPPs), adjusted for inflation, the greatest absolute increase in GDP in a single year ever recorded outside China was by the US in 1999 when it added $567 billion in output. The highest increase in production every achieved in a single year by Japan, frequently thought of as a post-war ‘miracle economy’, was $212 billion. But in 2010 China added $1,126 billion in output.2 China’s GDP increase in a single year was more than twice that ever achieved by the US and five times that of Japan.

China’s rapid growth has transformed its place in the world economy. Indeed, the scale of this transition is frequently underestimated, due to use of a misleading method of categorising and ranking countries without taking account of their population. This illogically gives the same weight to Monaco, a country with a population of under 40,000 and a higher per capita GDP than China, and India with a population of 1.2 billion, or Indonesia with a population of nearly 240 million, and lower per capita GDPs than China. This has the effect of confusing, not clarifying, China’s real position in the world economy. Serious calculations of China’s position in the world economy must take population into account.

Making calculations in terms of world population, when China’s ‘reform and opening up’ began in 1978 less than 1% of the world’s population lived in countries with a per capita GDP lower than China’s - 74% lived in countries with a higher GDP per capita measured in current dollars. By 2012 the situation was transformed - 29% of the world’s population lived in countries with a higher GDP per capita than China and 51% lived in countries with a lower GDP per capita – Figure 1. China had therefore moved into the top half of the world’s population in terms of economic development, with less than a third of the world’s population living in more economically developed economies. No comparable improvement in the position of such a large proportion of the world’s population has ever previously taken place in human history.

Figure 1

China’s successful response to the international financial crisis

In addition to this long term growth, China has come through the international financial crisis far more strongly than any other major economy. Between the 2nd quarter of 2007 and the 2nd quarter of 2014 China’s economy grew by 78% compared to 8% for the US – and the US was the best performing of the major developed economies. Therefore not only was China’s long term growth performance higher than that of other economies but its short term anti-crisis macroeconomic policies were also superior to those of any other major economy.

Figure 2

Economic laws and specific national situation

Given that China’s economic growth is without precedent in world history, its implications for economic theory are therefore decisive – no economic theory which cannot explain China’s success can be correct. However, this question of the relation of China’s economic growth and general economic theory immediately encounters the preliminary issue of whether China’s economic development was wholly specific, in which case few if any lessons can be drawn, or whether it was based on economic forces operating globally.

This issue is well addressed on the opening page of a study by Deng Rong of her father Deng Xiaoping. She notes:

“After the People’s Republic was established, we had more than seven years of successful socialist reform and construction. But then, the domestic and international situation, plus the combined influence of our victories, inflated self-confidence, and overheated brains, engendered inside the Party a kind of joyous arrogance. An exaggerated estimation of our accomplishments, plus an eagerness to speed up the progress… further stirred unrealistic thinking and opened a broad avenue for impetuous surges in violation of the laws of economics.”3

This analysis poses a fundamental question. On the one hand China insists on the entirely specific character of its own development – emphasised by its self-characterisation as socialism ‘with Chinese characteristics’, references to a political system ‘with Chinese characteristics’, a legal system ‘with Chinese characteristics’, industrialization ‘with Chinese characteristics’, urbanization ‘with Chinese characteristics’ and the concept of the specific ‘China dream’.4 As Deng Xiaoping emphasised: ‘To accomplish modernization of a Chinese type, we must proceed from China’s special characteristics.’5 Similarly Justin Yifu Lin emphasises, discussing practical applications of economic policy:

“we can never be too careful when it comes to the application of a foreign theory, because with different preconditions, no matter how trivial they seem, the result can be very different.”6

This emphasis on specificity is indeed correct. In fact, to pose the issue in the most general terms, not merely is each country different, but each country is itself different at each point in time – specificity is not only geographic but chronological. Not only is Germany not China, but China in 1949 is not China in 2014. In the famous and correct dictum of Heraclitus, nobody “ever steps in the same river twice”.

Nevertheless, simultaneously with this insistence on the entirely specific character of China’s development, Deng Rong’s passage speaks of ‘laws of economics,’ and ‘laws’ by their nature are universal. Deng Xiaoping stated this clearly by speaking not only of China’s specific character, its ‘Chinese characteristics’, but also that: ‘We have tried to act in accordance with objective economic laws.’7 Is there, therefore, a contradiction between the simultaneous assertion of the entirely specific character of China and of ‘universal’ economic processes? If so, of course, there is no point in trying to understand China’s economic development in terms of general economic processes, as China would be entirely specific, not governed by the laws of economics that apply elsewhere.

A unique combination of universal elements

In fact there is no contradiction between the concept of China’s uniqueness and of universal/global economic laws to which it is subject. Any practical economic analysis is not of an abstract idea but of a material reality. The fundamental structural elements of every economy (consumption, investment, savings, primary industry, manufacturing industry, service sector, trade, money etc.) are universal. But the specific way in which these universal elements combine and are interrelated in any economy is entirely unique both in place and time.

It follows from this no country can copy another. If one country applies the same policy as another, in what is inescapably its own and therefore a different situation, it is necessarily making a mistake – not only the other country’s situation but its own is specific. But, equally, a country can learn from others, as China did, by analysing the elements of which other economies are composed, and analysing how these elements combine differently in its own specific situation.

Deng Xiaoping, and the other architects of China’s economic reform, were therefore accurate in stating simultaneously that China’s policies were wholly specific and that they were acting in accordance with ‘universal’ economic forces.

Universal elements

In order to understand the relation between the universal elements in economic growth and their specific combination in China, and derive lessons for other countries, it is therefore necessary:

i. to study these universal elements and their operation;

ii. To analyse the specific combination of these elements in China.

However, to most accurately analyse these ‘universal’, that is global, elements it is necessary to grasp advances in understanding of the causes of economic growth, and its measurement, in the last decades.

Modern advances in Western econometrics

In the last three decades major advances in measurement of the causes of economic growth have taken place, leading to clearer understanding of economic growth in general and the causes of China’s growth. These advances, which are now formally recognised by the UN, US, and OECD may be briefly summarised.

The formalisation of the study and measurement of the causes of economic growth, technically known as ‘growth accounting’, was originally carried out in the 1950s by Robert Solow.8 Solow himself primarily considered two inputs, capital and labour, but a strength of his framework was that other inputs can and have been added.9 In his ground-breaking papers Solow, however, made two errors which were corrected later by others and which are directly relevant to analysis of economic growth in general, of China and Asia’s economic success, and therefore of policy conclusions that may be drawn from it.

First, Solow did not include ‘intermediate products’, the unfinished inputs of one industry into another, in his analysis (e.g steel into the motor industry etc.). This was crucial quantitatively because factual study shows intermediate products grow even more rapidly than capital, labour, and productivity during economic development. This rise of ‘intermediate products’ is an index of the growing division of labour domestically and internationally.

Second, Solow’s calculations made the error of not taking into account improvements in the quality of investment and labour. This led to the erroneous conclusion that the majority of economic growth came from productivity increases – an error repeated in some discussions of China.10 This latter mistake was subsequently corrected, and accurate methods of calculating growth were formally adopted by the US, UN and OECD.11

Such corrections are important for economies in general and are of particular relevance for China – many continuing errors in interpreting China’s economic growth turn out to not to be due to problems in China but to people using inaccurate measuring rods!12 The erroneous idea exists in some discussions in China that ‘productivity’, more strictly TFP, can be the chief driving force of economic growth. This idea, for reasons analysed in detail below, is false. Capital investment is a far more important source of economic growth than productivity, and becomes increasingly so as an economy becomes more advanced.

Accurately measuring with the most advanced Western econometric methods, it is easy to show that China’s economic growth follows an entirely comprehensible pattern – again confirming Deng Xiaoping’s assertion that China simultaneously follows an entirely specific path of development, its ‘Chinese characteristics,’ and the ‘universal laws’ of economics.

Advances in the study of economic growth in general allow a clear understanding of the ‘universal’ elements of China’s growth.

Division of labour

The significance of Solow’s error in leaving out intermediate products was immediately highlighted by subsequent empirical studies confirming that the growth of intermediate products, i.e, increasing division of labour, is the most rapidly expanding factor in economic development. For example, regarding the US, the most developed economy, Jorgenson, Gollop and Fraumeni found:

“the contribution of intermediate input is by far the most significant source of growth in output. The contribution of intermediate input alone exceeds the rate of productivity growth for thirty six of the forty five industries for which we have a measure of intermediate input.”13

Considering findings for the US economy in more detail Jorgenson noted:

“Comparing the contribution of intermediate input with other sources of growth demonstrates that this input is by far the most significant source of growth. The contribution of intermediate input exceeds productivity growth and the contributions of capital and labour inputs.”14

To illustrate this, Table 2 shows Solow’s original growth accounting categories – capital, labour, TFP - together with a column for growth of intermediate inputs. As may be seen, over the period 1977-2000, the median rate of growth of intermediate inputs in the US economy was 115% of the rate of growth of US GDP - far higher than any other input.

The same result as for the US was found for other economies - specifically including China. Regarding rapidly growing Asian economies:

For South Korea, Hak K. Pyo, Keun-Hee Rhee and Bongchan Ha found regarding material intermediate inputs: ‘The relative magnitude of contribution to output growth is in the order of: material, capital, labour, TFP then energy.’15

For Taiwan Province of China, analysing 26 sectors in 1981-99, Chi-Yuan Liang found regarding intermediate material inputs: ‘Material input is the biggest contributor to output growth in all sectors during 1981-99, except… seven’.16

For mainland China, Ren and Sun found that in the period 1981-2000, subdivided into 1984-88, 1988-94 and 1994-2000: ‘Intermediate input growth is the primary source of output growth in most industries.’17

Division of labour at an international level and China’s ‘Opening Up’ policy

This question of understanding the importance of division of labour makes clear, from a global/universal economic perspective, the significance of China’s ‘opening up’ policy. Division of labour is not purely domestic. The key trends in globalisation - rising share of trade in GDP, rising ratio of foreign direct investment to GDP, plus studies of particular industries - are powerful evidence of increasing international division of labour.

These realities therefore have immediate consequences for China’s ‘opening up’ strategy. In particular, the fact division of labour is the most powerful quantitative factor in economic growth immediately determines which development strategies will and which will not work.

The consequences of division of labour being the most powerful factor in economic growth drives globalization and dooms ‘import substitution’ strategies – the latter being the dominant form of attempts to build up a self-contained national economy.

This fact, in turn, leads to a correct understanding of the crucial importance of exports in China’s economic growth. The issue is not that China should develop exports in order to achieve a balance of payments surplus – on the contrary, China should aim at balance in its balance of trade, with imports developing as strongly as exports. The issue is that in a modern economy division of labour is on a larger scale than can be contained in the framework of the domestic economy. Only a large scale export orientation, and equally strong growth of imports, can allow adequate use of the advantages to be gained from this international division of labour. It is for this reason that maintaining the export dynamic of the economy remains crucial – it is directly linked to its efficiency and productivity.

Success of ‘opening up’

This importance of exports for China is confirmed by the wide range of empirical studies supporting the theoretical conclusion that more outwardly oriented economies achieve significantly higher rates of real growth of GDP. It is China’s rejection of ‘import substitution’ strategies that is the first distinctive feature of its economic policy.

The success of China’s ‘opening up’ policy is so evident, and has been stressed by numerous authors, that it is unnecessary to give excessive detail here.18 It is however worth noting that China is much more open to international trade than the US. As Japan is the world’s third largest economy, it is also illustrative to include it in comparisons.

As shown in Figure 3, in 2012 China’s exports were 27% of GDP compared to only 15% for Japan and 14% for the US. Consequently China’s export sector is almost twice as large a proportion of its economy as is that of the US. That China is a much more open economy in trade than the US or Japan gives China a competitive advantage over the US and Japan in promoting more rapid growth.

China’s openness to foreign trade is also much higher than a number of other large developing economies.

Figure 3

Investment

After division of labour, modern economic research shows capital investment is the second most important source of economic growth. This is of particular relevance to studying China, and economic growth in general, as it is an area in which some economic discussion in China remains confused – as it continues to hang on to the incorrect idea that TFP growth, not capital investment, is a more powerful factor in economic growth, when modern research shows clearly this is erroneous.

The finding that investment is the second most important force in economic growth, considerably exceeding the contribution of productivity, applies not only in China but in all rapidly growing Asian economies - Asia being the only part of the world in which countries have gone from poverty to ‘first world’ living standards in a single lifetime. Analysing what created this ‘Asian miracle’ is therefore evidently of great importance not only for China’s but for economic policy of all countries.

The result of applying up to date economic methods to study Asia’s rise to prosperity is clear - and directly underpins the understanding of the reasons for China’s economic success. After division of labour, both domestic and international, reflected in their ‘open’ character, the overwhelming cause of the Asian economies rise to prosperity was huge accumulation of investment. As Vu Minh Khuong finds in his The Dynamics of Economic Growth, by far the most comprehensive study of Asia’s economic growth:

“Capital accumulation was… the primary driver of Developing Asia’s lead over other parts of the world in terms of economic growth.”19

There were no exceptions in this pattern of successful Asian development:

“The pattern of rapid growth driven by intensive capital investment… is consistent over time and robust to different types of economies in terms of size, location… and level of development.”20

Very high capital investment accounted for 54% of the growth lead of developing Asian economies over the Western industrialized economies and for 62% of developing Asia’s lead over other developing economies. High capital investment was almost twice as important as productivity increases in explaining Asia’s growth lead over advanced economies. Asia’s pattern of capital investment playing a decisive role in economic growth, far higher than TFP, replicated the finding for the US of Jorgenson and others.

China’s pattern of very high capital accumulation was therefore simply the most advanced case of the “Asian miracle” – a clear illustration that while the specific combination of elements was entirely unique in China, creating its ‘Chinese characteristics’, the economic driving forces of China’s growth were universal/global in character. As Vu notes: “The pattern showing the stronger expansion of fixed investment relative to GDP was even more notable for China, which was the most rapidly growing economy in the region during 1990-2010.”21

Again giving exact numbers: “the share of the [developing Asian] region in the world’s GDP increased by 14.9 percentage points during 1990-2010, while its share in the world’s fixed investment rose by 29.1 percentage points… China’s share in the world’s GDP increased by 10.1 percentage points, while its share in the world’s fixed investment raised by 24.7 percentage points.”22

Capital accumulation as the global driving force of growth

It is crucial to understand that this fact investment drove China and Asia’s rise to prosperity was not unusual. Modern econometrics shows that investment is the main factor, after division of labour/intermediate products, in economic growth in all parts of the world economy:

“the importance of capital accumulation as the driving force for economic growth is not unique to Asia but pervasive worldwide… This source of growth is important not only for the developing countries, in which the capital stock per capita is low, but also for developed nations, in which the capital stock per capita is relatively high... for the G7 economies, investment in tangible assets was the most important source of economic growth and the contribution of capital input exceeded that of total factor productivity (TFP) for all countries for all periods.”23

The specific feature of China’s rapid economic growth, and the East Asian economies rise to prosperity, was therefore not that it was ‘investment led’ but simply the exceptional quantitative degree to which China mobilised investment. Dale Jorgenson, the world’s leading authority on measurement of the causes of economic growth, whose work led to the changes in the methods of official calculation of economic productivity and growth in the US, OECD and UN, writes in his introduction to Vu’s study:

“The emergence of Asia… is the great economic achievement of our time. This has created a new model for economic growth built on globalization and the patient accumulation of human and non-human capital.”24

Study of Asia also confirms previous findings that as a country moves towards being an advanced economy the role played by investment in its growth increases. This is shown in the chart below. Taking countries in ascending order of economic development, the percentage of growth due to investment is 50% in non-Asian developing economies, 55% in Asian developing economies and 57% in advanced economies. Growth in advanced economies is therefore more ‘investment led’ than in developing economies – i.e. development to advanced economy status leads to growth becoming more investment intensive.

Figure 4

The quantitative determinants of economic growth

These global facts have clear implications for China, and for economic growth in general. Productivity is too small a part of economic growth, accounting for only 11% of growth in advanced economies, to be the main driver of development compared to capital investment which accounts for 57% of growth. Any policy relying primarily on boosting productivity therefore cannot be successful for this basic quantitative reason.

The erroneous view that productivity, not investment, accounts for the majority of economic growth came from the fundamental mistake of Solow in not controlling in his calculations for changes in the quality of inputs of capital and labour. Once this error is corrected it is clear capital investment is the decisive factor in economic growth, with productivity playing a relatively small role. The facts Jorgenson noted regarding the first studies using modern statistical methods for the US have been confirmed by the subsequent data:

“Griliches and I showed that changes in the quality of capital and labor inputs and the quality of investment goods explained most of the Solow residual [TFP]. We estimated that capital and labor inputs accounted for 85 percent of growth during the period 1945-1965, while only 15 percent could be attributed to productivity growth.”25

Official changes in measuring economic growth

The result of the formal changes in the methods of measuring economic growth in the last three decades was succinctly summarised by Jorgenson:

“The final demise of the traditional [Solow derived] framework for productivity measurement began with the Panel to Review Productivity Statistics of the National Research Council, chaired by Albert Rees. The Rees Report of 1979, Measurement and Interpretation of Productivity, became the cornerstone of a new measurement framework for the official productivity statistics… The BLS framework included a constant quality index of capital input, displacing two of the key conventions of the traditional framework of Kuznets and Solow.

“However, BLS retained hours worked as a measure of labor input until 11 July 1994, when it released a new multifactor productivity measure including a constant quality index of labor input as well. Meanwhile, BEA [Bureau of Economic Analysis ] had incorporated a constant quality price index for computers into the national accounts… This index was incorporated into the BLS measure of output, completing the displacement of the traditional framework of economic measurement by the conventions employed in my papers with Griliches.

“The official BLS estimates of multifactor productivity have overturned the findings of Abramovitz and Kendrick, as well as those of Kuznets and Solow...

“The approach to growth accounting in my 1987 book with Gollop and Fraumeni and the official statistics on multifactor productivity published by the BLS in 1994 has now been recognized as the international standard. The new framework for productivity measurement is outlined in Measuring Productivity, a manual published by the Organisation for Economic Co-Operation and Development.”26

These changes in the methods of the calculation of economic growth, and its determinants, have therefore been made officially by the most important world’s most important statistical agents – and confirm the finding that capital investment is a far more powerful factor in economic growth than productivity. It is therefore somewhat astonishing that in China one sometimes finds methods of measuring growth used which have been officially overturned, and false claims made that productivity is the decisive factor in growth, when this has been shown to be false by accurate methods of economic measurement.

Successful and failed strategies for growth

It follows from the above facts on economic growth that of course attention must be given to policy to maintain the rate of productivity growth, via a high marginal rate of return on capital, but by the largest part of growth will necessarily have to come from investment. As Vu notes:

“The secret of successful Asian economies, therefore, lies not in achieving high TFP growth but in sustaining reasonable TFP growth despite the intensive mobilization of factor inputs over extended periods.”27

These modern advances in the study of measurement and causes of economic growth, as well as the practical examples of China’s and Asia’s economic growth, therefore also clearly settle the issue of the difference between two possible growth strategies - and explain why the Western economies have had relatively slow growth compared to China and the dynamic Asian economies. The difference between these two strategies has clear and fundamental implications for China’s economic policy both today and in the future.

(i) The first strategy, the one confirmed by the facts, is that the primary factor in economic growth is accumulation of capital and labour (factor accumulation) and that productivity (TFP), while significant is less quantitatively important than factor accumulation. Such a growth strategy was pursued in the developing Asian economies and above all in China. It follows from this reality that the key policy goal is to maintain a reasonable rate of TFP growth but fundamentally to ensure participation in international division of labour (an ‘open’ economy) and achieve a high mobilisation of factors of production (capital and labour) – in particular a high investment level.

This strategy, as it is in line with the fundamental weight of factors of production in growth, has been a spectacular success, creating the fastest increases in living standards seen in human history, lifting hundreds of millions out of poverty, now creating `first world' living standards in a series of what were originally `third world' countries (south Korea, Singapore etc.), and bringing China from a poor country to the brink of ‘high income’ countries by World Bank criteria.

(ii) The alternative strategy conceives that factor accumulation, of capital and labour, is not as important for growth as TFP. This is the policy that has been applied in the advanced economies, and has accompanied their economic slowdown. As Jorgenson notes: ‘The growth strategy of many advanced economies emphasizes innovation, which has been quite satisfactory for the past decade, but neglects investment in human and non-capital, which continues to fall.'28

Failure of the TFP based strategy is inevitable, as TFP simply accounts for too small a part of growth to be the main driver of economic development.

The two different analyses, therefore, have two different practical policy conclusions:

(i) if the most important driver of economic growth, after participation in division of labour via maintaining an ‘open’ economy, is factor accumulation then the most important policies are those promoting high rates of factor growth. These include high savings rates (to finance capital investment), policies to widen participation in the labour force (as this increases labour supply), promotion of education (as this increases labour inputs via increasing labour quality) etc. A reasonable rate of growth of TFP must be maintained, but is quantitatively not as important as policies which facilitate factor accumulation. Precisely as Vu summarized: `the secret of the Asian growth model lies not in achieving high TFP growth but in sustaining reasonable TFP growth despite the intensive mobilization of factor inputs over extended periods.'29

It should be noted that modern econometrics shows investment is a far more important factor that TFP in all parts of the world economy – and therefore the strategy based on maintaining reasonable levels of TFP growth, but above all seeking mobilisation of factors of production, equally applies to economies at all stages of development:

“the importance of capital accumulation as the driving force for economic growth is not unique to Asia but pervasive worldwide. For example, Jorgenson and Siroh..., Oliner and Sichel... found that capital input is the most important source of growth in most economies. This source of growth is important not only for the developing countries, in which the capital stock per capita is low, but also for developed nations, in which the capital stock per capita is relatively high... even for the G7 economies, investment in tangible assets was the most important source of economic growth and the contribution of capital input exceeded that of total factor productivity for all countries for all periods examined.”30

Indeed, as TFP growth in advanced economies is low, the more advanced the economy the more important is factor mobilisation – in particular investment.

(ii) Alternatively, if the main locomotive of growth is erroneously believed to be TFP growth, then initiatives promoting factor accumulation (high saving rates, widening participation of the population in the work force etc.) are not so important as policies assumed to increase productivity.

The facts confirm that the downplaying of capital investment and labour development in the advanced economies in the recent period has been unsuccessful as a growth strategy – an inevitable result as TFP by itself is too small a part of the economy to create rapid economic growth.

It is therefore inevitable that as Jorgenson notes, the successful growth strategy of Asia, and China in particular, is counterposed to, and proved itself superior, to those strategies based on TFP growth (innovation, entrepreneurship) in Europe and the US. As Jorgenson notes: `Economic commentators, especially those outside Asia, have been reluctant to recognize the new paradigm for economic growth that originated in Asia, since this would acknowledge the failure of Western ideas.'31

Summary

In conclusion, the findings of modern economic research are therefore unequivocal and have led to formal changes in the way economic growth and its causes are measured. It is, consequently, a significant error that in parts of economic discussion in China methods of measuring economic growth and its determinants are used which are 30 years out of date.

1. The findings of modern economic research show that a claim that TFP was the main source of economic growth was based on the statistical errors of not including intermediate products (division of labour) and not controlling for the effect of change in the quality of investment and labour inputs. Once these necessary statistical corrections are made it is clear TFP plays only a relatively small role in economic growth and growth of inputs, above all investment, plays the decisive role in the growth factors. It is this which explains the speed of China’s growth, and that of the other dynamic Asian economies.

2. China’s economic development has a unique and specific character – its ‘Chinese characteristics’. This unique character, however, is a specific combination of economic forces which are global in character. Deng Xiaoping, and others who created China’s economic policy, were therefore correct in stating they were simultaneously following uniquely Chinese policies and operating according to universal laws of economics.

3. China’s ‘opening up’ policy is rooted in the fact that domestic and international division of labour, statistically reflected in the growth of intermediate products, is the most powerful force of economic development. Only an ‘open’ policy, i.e. participation in international division of labour, not import substitution, can be the basis of rapid economic growth in any economy.

4. China’s pattern of growth driven by very high investment levels corresponds to the general global forces propelling economic growth. Capital investment, after division of labour, is the most powerful force of economic growth in both developed and developing economies. For basic quantitative reasons, strategies based on TFP growth (e.g. promoting ‘entrepreneurship’) cannot be successful in generating economic growth. This therefore shows the correctness of concepts that the key goal of development policy should be to alter ‘factor endowments’ so that economies for their development gradually make the transition from labour intensive to capital intensive production – i.e. the role of capital investment increases as an economy becomes more developed.

* * *

This is a greatly expanded version of a paper presented at the Chongyang Institute for Financial Studies, Renmin University of China, Second Annual G20 Think Tank Summit on 3-4 September on "Great Finance and Global Comprehensive Growth".

Notes

1 This is of course rapid growth by the standards of the relevant period.

2 Calculated from (The Conference Board, 2014) Calculated in EKS PPPs

3 (Deng R. , 2002, p. 1)

4 The different categories with ‘Chinese characteristics’ are from (Wen J. , 2011). The term ‘China Dream’ is of course from Xi Jinping.

5 (Deng X. , 30 March 1979)

6 (Lin, 2012, p. 66) Emphasis deleted from the original.

7 (Deng X. , 30 March 1979, p. 173) Equally Deng Xiaping spoke of the ‘universal truth of Marxism-Leninism’ (Deng X. , 2 June 1978). This insistence that China acted simultaneously in accord with its specific conditions and universal laws was continuously asserted by Deng Xiaoping in numerous different contexts. For example:

‘Our principle is that we should integrate Marxism with Chinese practice and blaze a path of our own. That is what we call building socialism with Chinese characteristics.’ (Deng X. , 21 August 1985)

‘The Chinese revolution succeeded by integrating the universal principles of Marxism-Leninism with the concrete practice of China.’ (Deng X. , 31 May 1980)

‘the Chinese revolution succeeded by integrating the universal principles of Marxism-Leninism with the concrete practice of China, we should not demand that other developing countries, let alone the developed capitalist countries, adopt our model in making revolution. Of course, one cannot demand that they all adopt the Russian model, either.

‘We were victorious in the Chinese revolution precisely because we applied the universal principles of Marxism-Leninism to our own realities.’ (Deng X. , 28 August 1985)

Deng, X. (28 August 1985). Reform is the only way for China to develop its productive forces. In X. Deng, Selected Works of Deng Xiaoping 1982-1992 (1994 ed., pp. 140-143). Beijing: Foreign Languages Press.

Deng, X. (30 March 1979). Uphold the Four Cardinal Principles. In 2001 (Ed.), Selected Works of Deng Xiaoping 1975-1982 (pp. 166-191). Honolulu: University Press of the Pacific.

Deng, X. (31 May 1980). An important principlefor handling relations between fraternal parties. In X. Deng, Selected Works of Deng Xiaoping 1975-1982 (1984 ed., pp. 300-301). Honolulu: University Press of the Pacific.

Wen, J. (2011, March 5). Report on the work of the government: delivered at the fourth session of the eleventh National People's Congress on March 5, 2011. Retrieved March 5, 2011, from China Real Time Report: http://blogs.wsj.com/chinarealtime/2011/03/05/china-npc-2011-reports-full-text/